Like other forms of company stock, Restricted Stock Units, or RSUs, are granted to employees to attract, reward, and retain them. This can be when you’re first hired, or later on as a bonus (or both!).

What Are Restricted Stock Units?

Employers offer RSUs as an additional form of compensation in the form of company stock. They grant of a certain number of RSUs, but you’re not actually issued any shares until they vest. Often times, you need to wait a year for the first portion to vest.

Once vested, the shares are no longer restricted and the employer will distribute the shares of company stock to the employee.

How Are They Taxed?

The distributed shares you receive after they vest are considered income, and a portion of the shares will be withheld to pay income taxes at ordinary income tax rates. If you hold onto the rest of the shares for 12 months or longer, you’ll pay the lower capital gains tax on the gain of any shares you sell (usually 15% for most people). If you sell your shares less than 12 months after they vest, you’ll pay ordinary income tax on the gain.

How Would This Work IRL?

In year 1: 1,000 shares vest when the stock price is $20 ($20,000 taxed as ordinary income)

In year 2: 1,000 shares vest when the stock price is $25 ($25,000 taxed as ordinary income)

In year 3: 1,000 shares vest when the stock price is $30 ($30,000 taxed as ordinary income)

In year 4: 1,000 shares vest when the stock price is $35 ($35,000 taxed as ordinary income)

Overall, $110,000 was taxed as ordinary income on each vesting date and taxes were withheld.

What if the stock continues to rise after you’re 100% vested and you sell your shares for $50 per share, or $200,000, 14 months after the final vesting date? Since you’ve held your shares for longer than 12 months, the entire gain of $90,000 is taxed at the long-term capital gains tax rate.

What Would You Do If You Got a Bonus?

Financial planners often recommend selling your RSUs as soon as they vest, since you’ll pay ordinary income taxes on them upon vesting. Usually, clients have other financial priorities that are more pressing than buying stock in their company. Things like: paying down debt, building up savings, investing for retirement, and building up a more diversified brokerage account come to mind.

The best way to think about what to do when your RSUs vest is to answer this question: if you received a $10,000 bonus what would you do with the money? If your answer was anything other than: run out and buy company stock, then you’re better off selling your RSUs and using that money to fund your other financial goals.

How Do RSUs Compare to Other Company Stock?

Similar to ISOs and NSOs, RSUs vest over time and can be distributed based on your company meeting certain goals, like achieving a certain amount of revenue. However, RSUs don’t have a strike price, which means they’ll still hold value as long as the company’s stock has value, even if the company’s value doesn’t grow over time.

The one area where options, specifically ISOs, have an advantage is taxation. Since recipients of ISOs don’t pay tax when their options vest, it’s possible to pay taxes on the entire gain at the lower long-term capital gains tax rate.

When to Get Help

Because you’re taxed both with RSUs vest and when you sell shares, it may be helpful to talk to an accountant or financial planner when you’re first granted RSUs. It’s important to understand how RSUs fit into your overall financial and tax planning.

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